“The US dollar has long played an outsized role in world markets, yet central banks do not now hold it in their reserves to the extent that they once did,” they said.
They added: “In an example of the broader change in the composition of foreign exchange reserves, the Bank of Israel recently revealed a new strategy for its more than $200 billion of reserves. Starting this year, it will reduce the participation of US dollars and will increase portfolio allocations to the Australian dollar, the Canadian dollar, the Chinese renminbi and the Japanese yen.
However, IMF economists noted that the reduced role of the US dollar was also not matched by gains in shares of other traditional reserve currencies such as the euro, yen and pound. Instead the currencies of smaller economies that have not traditionally featured prominently in reserve portfolios, such as the Australian and Canadian dollars, the Swedish krona and the South Korean won, now account for three-quarters of the turnaround.
“While there has been some increase in the proportion of reserves held in renminbi, this represents only a quarter of the shift away from dollars in recent years, in part due to China’s relatively closed capital account,” the report said.
This is due to two factors:
- These coins combine higher returns with relatively lower volatility. This increasingly appeals to central bank reserve managers as foreign exchange reserves grow, raising risks to portfolio allocation;
- New financial technologies, such as automated market making and automated liquidity management systems, make it cheaper and easier to trade currencies from smaller economies.
Furthermore, an update to the data referenced when describing the drain on the dollar’s dominance showed that at the end of last year, a single country, Russia, held almost a third of the world’s renminbi reserves.
This behavior away from the US dollar responds to what economists called “more plausible explanations.”
“It’s that these non-traditional reserve currencies are issued by countries with open capital accounts and a history of strong, stable policies. Important attributes of reserve currency issuers include not only economic weight and financial depth, but also transparent and predictable policies. In other words, the stability of the economy and political decisions are important for international acceptance,” they stressed in the document published on Wednesday.
Already in the final stretch, they also reported how a “regression analysis of global reserve currency stocks” confirms that a higher economic risk premium, measured by the cost of using credit derivatives to insure against default reduces a currency’s share of global reserves.
“Obviously, holders prefer the currencies of countries known for their good governance, economic stability and sound finances,” the IMF said.
Source: Ambito
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